****

**SFFAS 54 LEASE GUIDANCE:**

**RIGHT-TO-USE LEASES:**

**DEEMED “OPERATING LEASES” FOR BUDGETARY TREATMENT**

**WITH A CANCELLATION CLAUSE**

**GAIN/LOSS ON CANCELLATION**

**EFFECTIVE FISCAL YEAR 2024**

**PREPARED BY:**

**GENERAL LEDGER AND ADVISORY BRANCH**

**BUREAU OF THE FISCAL SERVICE**

**U.S. DEPARTMENT OF THE TREASURY**

**RTU LEASE GUIDANCE: BUDGETARY OPERATING WITH CANCELLATION**

**Effective Fiscal 2024**

                                                                                                                                Page 40 of 41                                                                                             November 2022

**Proprietary Accounting Requirements & Agency Decision Points**

SFFAS No. 54, *Leases*, as amended by SFFAS No. 60 and SFFAS No. 61, replaces proprietary lease accounting and disclosure standards for general purpose federal financial reports. SFFAS No. 54 is effective for reporting periods beginning after September 30, 2023. (Early implementation is not permitted.)

A lease is defined as “a contract or agreement whereby one entity (lessor) conveys the right to control the use of PP&E (the underlying asset) to another entity (lessee) for a period of time as specified in the contract or agreement in exchange for consideration.” (SFFAS 54, Par. 6.)  SFFAS No. 54 requires that federal lessees recognize a lease liability and a right-to-use lease asset (also referred to as a lease asset), and that federal lessors recognize a lease receivable and unearned revenues at the commencement of the lease term, unless the lease meets the definitional criteria of a short-term lease, contract or agreement that transfers ownership, or an intra-governmental lease.

For proprietary accounting, entity management is responsible for exercising professional judgement and collaborating within its agency to reach certain determinations before establishing proprietary accounting treatment, including:

**1)** Lease Term, with consideration for Options, Renewals/Terminations, and Cancellation Clauses; 

**2)** Calculation of Lease Asset/Liability; with consideration for Fixed vs. Variable Payments; 

**3)** Selection of Proprietary Interest Rates - Amortization of Discount on Lease Liability/Receivable;

**4)**Modifications, Terminations, and any respective remeasurements; and

**5)** Contracts or Agreements Containing Nonlease and Lease Components (if applicable)

****

**Proprietary Lease Term & Cancellation Clauses**

For proprietary accounting, calculating the lease term is pivotal because the classification between short-term leases and right-to-use leases depends on the lease duration.  The lease term is determined to be the noncancelable lease period, plus certain periods subject to options to extend or terminate the lease. The noncancelable period is the shorter of the period agreed upon in the lease contract that: **(1)** precedes any option to extend the lease; or **(2)** precedes the first option to terminate the lease.  In addition, the lessee’s lease term should include the noncancelable period, along with periods:

· Involving an option to extend the lease, if it is probable that the lessee or lessor will exercise that option (SFFAS 54, Par. 15a & 15c)

· Following an option to terminate the lease, if it is probable that the lessee or lessor will not exercise that option (SFFAS 54, Par. 15b & 15d)

Some specific provisions may also need to be applied when determining the lease term:

· Periods for which the lessee/lessor **(1)** have an option to terminate the lease without permission from the other entity, or **(2)** have to agree to extend, are considered to be cancelable periods and are thus excluded from the lease term (SFFAS 54, Par. 19a.)

· An availability of funds/cancellation clause allowing lessees to cancel a lease agreement if funds for the lease payments are not appropriated should only affect the lease term when it is probable that the clause will be exercised (SFFAS 54, Par. 19c.)

· If a lessee has the option to purchase the underlying asset during the lease term and the contract is not a contract that transfers ownership, the lease term should exclude the period, after the date at which the option is probable of being exercised (SFFAS 61, Par. 6)

**Fixed Vs. Variable Payments**

The Lessee’s lease asset and the Lessor’s lease receivable should include the present value of payments expected to be made during the lease term.  Generally, these should include:

· Fixed payments;

· Variable payments that depend on an index or a rate;

· Variable payments that are fixed in-substance; and

· Any lease incentives receivable from the lessor.

For a complete list of payment types to include in the present value of payments, please see SFFAS 54, Pars. 40 and 56.)

Variable payments based on future performance of the lessee or usage of the underlying asset should be recognized as lease expense/revenue during the reporting period to which those payments relate.  These variable payments should NOT be included in the measurement of the lease liability/lease receivable (See SFFAS 54, Pars. 41 and 54.)  Reporting entity management should consult with appropriate procurement officials, and use professional judgment, to make determinations on what payments are fixed and what are variable.

**Proprietary Interest Rates - Amortization of Discount on Lease Liability/Receivable - Interest Expense/Revenue**

Future lease payments should be discounted using the interest rate the lessor charges the lessee. When the rate is not stated in the lease, SFFAS 61 allows agencies flexibility to use a rate based on a recent marketable Treasury security rate, or a historical average interest rate on marketable Treasury securities of a similar maturity to the term of the lease: “If the interest rate is not stated in the lease, the interest rate should be based on the interest rate on marketable Treasury securities at the commencement of the lease term (or at the subsequent financial reporting date), with a similar maturity to the term of the lease.” (SFFAS 61, Par. 6) Methodology for selecting interest rates based on marketable Treasury securities should be documented and should be consistent from period to period.

In subsequent reporting periods, the Lessee should calculate the amortization of the discount on the lease liability and recognize that amount as interest expense for the period. Any payments made should be allocated first to the accrued interest liability and then to the lease liability. (SFFAS 54, Par. 43)

Likewise, the Lessor should calculate the amortization of the discount on the receivable and report that amount as interest revenue for the period (SFFAS 54, Par. 60.)  

**Lease Amortization & Lessor Unearned Revenue**

During the lease term, the Lessee’s lease asset should be amortized in a systematic and rational manner, over the shorter of: The lease term; or the useful life of the underlying asset (See SFFAS 54, Par. 50, and SFFAS 60, Pars. 20-21.)

Meanwhile, the Lessor should recognize the unearned revenue in a similar manner. (See SFFAS 54, Par. 64, as amended by SFFAS 60, Par. 26.)

**Modifications/Terminations**

In the event a right-to-use lease is terminated before the end of the contractual lease term (other than by a transfer of ownership/purchase of the underlying asset), a Lessee should account for the termination by reducing the carrying values of the lease liability and the lease asset and recognizing a gain/loss for the difference.  Likewise, lessors should reduce the carrying value of the lease receivable and the related unearned revenue, and record a gain/loss for the difference.

**Contracts or Agreements Containing Nonlease and Lease Components**

For contracts or agreements containing both nonlease and lease components, in which the purpose of the contract is primarily attributable to the nonlease component(s), entities may elect to apply the practical accommodation in SFFAS 62.  

This practical accommodation allows for the entity to treat the entire contact (including lease components) as a nonlease contract and to expense/recognize as revenue the lease payments, rather than recognizing both expenses/revenue and lease assets/liabilities following the provisions of SFFAS 54. (See SFFAS 62 for complete details on how to make the election, along with how to apply certain reporting and disclosure requirements.

Entity management must use professional judgement to assess the nature of contracts or agreements to make the most appropriate decision on the primary purpose of the contract.  (SFFAS 62, Par. 5)

**Budgetary Accounting Requirements & Agency Decision Points**

While proprietary accounting requirements for leases are transformed by SFFAS 54, *Leases*, budgetary accounting requirements will remain unchanged and continue to be guided by the lease scorekeeping rule developed by OMB, CBO, and the House and Senate Budget Committees originally in connection with the Budget Enforcement Act of 1990, and guidance regarding this rule provided in*OMB Circular No. A-11, Appendix B, Budgetary Treatment Of Lease-Purchases and Leases of Capital Assets.*

For budgetary accounting, entity management is responsible for exercising professional judgement and collaborating within its agency to reach certain determinations before establishing budgetary accounting treatment, including:

**1)** Operating vs. Capital Lease (as defined by Appendix B of OMB Circular No. A-11); 

**2)**Budgetary Lease Term, with consideration for Cancellation Clauses;****

**3)**The Budgetary Interest Rate is selected per OMB Circular No. A-94, Appendix C guidance; and

**4)**Budget Authority and Outlays.

**Operating/Capital/Lease Purchase**

Reporting entities should apply professional judgment, consistent with the guidance in Appendix B of OMB Circular No. A-11, on Operating Leases/Capital Leases criteria to discern the correct budgetary treatment of each lease contract.  The differences in budgetary accounting treatment between Operating and Capital leases are extensive; see Appendix B of *OMB Circular No. A-11*for more details.  In order for a lease to qualify for Operating lease treatment for budgetary accounting purposes, a lease must meet the following criteria established in the scorekeeping rule:

· Ownership of the asset remains with the lessor during the term of the lease and is not transferred to the Government at or shortly after the end of the lease term;  

· The lease does not contain a bargain-price purchase option; 

· The lease term does not exceed 75 percent of the estimated economic life of the asset; 

· The present value of the minimum contractually required payments over the life of the lease does not exceed 90 percent of the fair market value of the asset at the beginning of the lease term; 

· The asset is a general purpose asset rather than being for a special purpose of the Government and is not built to the unique specification of the Government as lessee; and  

· There is a private sector market for the asset.”

**Lease Term & Cancellation Clauses**

When initiating lease contracts with a cancellation clause, entities are required to presume the lease will run for the full term of the contract when calculating the lease term as part of the budgetary accounting analysis necessary to distinguish between an Operating/Capital Lease.

“Cancellation clauses.  It will be presumed that the lease will run for the full term of the contract, and the minimum payments will be calculated on the basis of the lease and other contractually required payments that will be made over the full term of the lease (including options to renew).” (OMB Circular No. 11, Page 8 of Appendix B.)

**Budget Authority and Outlays – Operating Lease**

Budget Authority for Operating Leases should be recorded in an amount equal to the total contractually required payments under the full term of the lease, or (if there is a cancellation clause) the amount sufficient to cover first year lease and other contractually required payments plus cancellation costs up front. Meanwhile, outlays of Operating Leases are scored over the lease term in an amount equal to the annual lease and other contractually required payments.

“For operating leases, budget authority is required to be obligated up front in the amount necessary to cover the Government's legal obligations, consistent with the requirements of the Antideficiency Act.  This will include the estimated total payments expected to arise under the full term of the contract or, if the contract includes a cancellation clause, **an amount sufficient to cover the lease and other contractually required payments for the first year plus an amount sufficient to cover the costs associated with cancellation of the contract.  For each subsequent year, sufficient budget authority is required to be obligated to cover the annual lease payment for that year plus any additional cancellation costs.** For operating leases funded by the General Services Administration's Federal Buildings Fund (which is self-insuring under existing authority), only the amount of budget authority needed to cover the annual lease payment is required to be obligated.”

**Right-To-Use Leases Determined to be “Operating” for Budgetary Treatment- With Cancellation Clauses**

**Listing of USSGL Accounts Used in This Scenario:**

**Key Assumptions Driving Proprietary Accounting Entries:**

**Lease Term**

· A federal reporting entity (Lessee) signs a 5-year lease with a non-federal entity (Lessor) for the right to control/right to use equipment.  (For illustration purposes, the scenario also shows posting logic for a federal Lessor working with a non-federal Lessee under a separate heading.)

· For illustration purposes, the lease is assumed to begin at the start of the fiscal year, **10/01/2023.**

· No purchase option probable of being exercised exists.

· The lease includes an availability of funds cancellation clause that allows the Lessee to cancel the lease on an annual basis, if funds for the lease payments are not appropriated. Management determines it is not probable that the clause will be exercised.

· The lease contains a fixed $5,000 cancellation penalty. 

· Since management determines the cancellation clause is not probable of being exercised, the lease term is calculated at 5 years, and the lease is determined to be a Right-To-Use Lease.

· The Lessor charges the Lessee the Interest Rate on marketable Treasury securities as of the commencement of the lease term, per SFFAS 61 Paragraph 6 guidance, which for purposes of this scenario is assumed to be 10.00%.

· All monthly payments are made and considered disbursed at the last business day of the month – This scenario assumes payments are made directly to vendor and that there is no lag time between disbursement, authorization, and receipt.

**Lease Asset/Liability Calculation**

· The contract amount is $120,000 ($2,000 monthly payments x 60 months.)

· Management calculates the Present Value of all expected fixed payments to be $94,131.  The Lessor charges the Lessee the Treasury Rate of 10.00%. 

· The Lessor already has equipment on its Balance Sheet valued at $300,000 with $150,000 Accumulated Depreciation.

**Fixed & Variable Payments**

· Management determines the lease contains both fixed and variable payments.  Fixed payments include a minimum annual payment required by the lease contract, and lease payments (including interest) are paid at the start of the year.  

· In addition, there is a $12 per hour charge for the use of the equipment, which management deems to be a Variable payment based on future usage of the underlying asset. This variable payment will not to be included in the Lease Liability/Lease Receivable per SFFAS 54, Par. 41. (Also See Technical Release 20, Lease Implementation Guidance, Par. 48 for more information on Variable Payments.)

· Management determines that the Fixed minimum lease payment is "contractually required payments" per *OMB Circular A-11, Appendix B*.

· Management determines that the Variable costs related to the usage of the equipment are also "contractually required payments" per *OMB Circular A-11, Appendix B*, and estimates these to be $1,500 for each year of the lease term.

**Key Assumptions Driving Budgetary Accounting Entries:**

**Budgetary Authority**

· The Lessee received a direct appropriation and is working from a multi-year appropriated TAFS from a general fund expenditure account.  Agency management has concluded that appropriations language allows the budget authority to remain available for the lease and other contractually required payments over the full term of the lease.

· For illustration purposes, the lease is assumed to begin at the start of the fiscal year, **10/01/2023.**

· The Lessor charges the Lessee the Interest Rate from OMB Circular No. A-94, Appendix C guidance, which for purposes of this scenarios is assumed to be 10.00%.

· Management determines that the Fixed costs for the lease of equipment are "contractually required payments" per *OMB Circular No. A-11, Appendix B*.

· The lease is **not** funded by the General Services Administration's Federal Buildings Fund.

**Budgetary Lease Capital/Operating Determination**

· Management determines the lease to be an “**Operating lease**” for budgetary purposes **with****a cancellation clause**. Therefore, budget authority should include “an amount sufficient to cover the lease and other contractually required payments for the first year, plus an amount sufficient to cover the costs associated with cancellation of the contract.”  For each subsequent year, sufficient budget authority is required to be obligated to cover the annual lease payment for that year plus any additional cancellation costs.

**Budgetary Outlays**

· As an Operating lease per budgetary treatment, leases will be scored over the lease term in an amount equal to the annual lease and other contractually required payments. 

**Cancellation Clauses**

· The lease **includes** an availability of funds cancellation clause, with a fixed $5,000 cancellation penalty.  For this scenario, there is not an assumption of additional cancellation costs in subsequent years.

· The lease does not contain renewal/purchase options, and is not associated with government land.

**Proprietary Amortization Table**

· **Contract Amount $120,000**

· **5-Year Lease with 60 monthly payments of $2,000 each**

· **Interest Rate of 10.0% for Proprietary Accounting**

· **Present Value of Payments = $94,131**

· **Lessee Right-To-Use- Asset & Lease Liability amount: $94,131**

· **For illustration purposes, the lease begins at the start of the fiscal year, 10/01/23.**

· **Monthly payments are considered to be disbursed on the last business day of each month.**

**Schedule of Budgetary Resources/Contractually Requirement Payments**

· **Year 1 Budget Authority = 12 contractually-required monthly payments of $2,000 each = $24,000, plus $1,500 contractually-required Variable Costs, plus $5,000 cancellation penalty = $30,500.**

· **Year 2 Budget Authority = 12 contractually-required monthly payments of $2,000 each = $24,000, plus $1,500 contractually-required Variable Costs = $25,500.**

· **Interest Rate of 10.0% for Budgetary Accounting.**

· **Budget Outlays correspond to the monthly fixed payments over the lease term.**

**Disclaimer**

The below guidance is intended to serve as a reference only based on a finite number of underlying assumptions.  It is in no way intended to provide comprehensive posting logic for every leasing activity.  Agencies should have a thorough understanding of authoritative standards SFFAS 54, SFFAS 60, and SFFAS 61 and apply other factors, including but not limited to certain prepayments, accruals, etc.  As stated above, agency management must exercise professional judgement and collaborate within their agency to reach determinations of lease activities on a lease-by-lease basis, before establishing accounting treatment.

Entity management should document these decisions and incorporate them into management’s existing OMB Circular No. A-123, “Management's Responsibility for Enterprise Risk Management and Internal Control,” Appendix A, procedures.

****

****

**FISCAL YEAR 1 - Right-To-Use Leases; “Operating” for Budgetary Treatment; With A Cancellation Clause**

**Lessee Accounting – FY 1**

**Lessor Accounting – FY 1**

****(For simplicity, the recurring entries of Lessor Receipts for Months 7-12 are not illustrated, but amounts can be seen in the amortization table.)****

**Fiscal Year 1 Post-Closing Adjusted Trial Balance:**

**Year 1 Financial Statements:**

**Year 1 Reclassified Financial Statements:**

**FISCAL YEAR 2 - Right-To-Use Leases; “Operating” for Budgetary Treatment; With A Cancellation Clause**

**Lessee Accounting – FY 2**

**Lessor Accounting – FY 2**

****(For brevity, the recurring entries of Lessor Receipts for Months 7-12 are not illustrated, but amounts can be seen in the amortization table.)****

**Fiscal Year 2 Post-Closing Adjusted Trial Balance:**

**Year 2 Financial Statements:**

**Year 2 Reclassified Financial Statements:**

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